October 2, 2026 · 7 min read
What Is a 409A Separation from Service? Definition and Examples
When leaving a job counts as leaving under the tax rules for deferred pay: cutting your hours, long leave, consulting and the six-month wait at public companies.
- Tax
- Deferred compensation
- Leaving a company
A 409A separation from service is the point at which leaving an employer counts as leaving under Section 409A. It can be death, retirement or a termination of employment. A permanent drop in work to 20% or less of your average over the previous 36 months also counts. Only then can deferred pay tied to leaving, meaning pay earned earlier and paid later, be paid.
This matters because the date in the HR system and the 409A date can differ. Take a founder who steps back to a part-time advisory role, an executive on a long leave or a consultant whose contract is about to be renewed. Each may still be “in service” for 409A. Severance or a deferred bonus paid to them on the HR date would be paid too early.
20%
Share of your average services over the past 36 months, or less, at which you are presumed to have separated
6 months
Length of a genuine leave of absence after which employment is deemed to end, unless you keep a right to return by law or contract
29 months
The longer leave period allowed when you are absent because of a qualifying medical impairment
How Does 409A Separation from Service Work?
Separation from service is the first of the six events on which Section 409A allows deferred pay to be paid. The statute leaves its meaning to the Treasury. The regulation’s test looks at what both sides expected, and paperwork alone does not settle it. Did you and the employer reasonably expect that you would do no further work after a certain date? Or did you expect your bona fide services, meaning the real work you do, to fall permanently to no more than 20% of their average over the 36 months just before?
The 20% and 50% Presumptions
Two presumptions make the test workable. If your bona fide services fall to 20% or less of the 36-month average, you are presumed to have separated. If they stay at 50% or more, you are presumed not to have. Between the two, there is no presumption, and the facts decide. Are you still treated as an employee for pay and benefits? Were similar people treated the same way? Are you free to work for others in the same line of business? Either presumption can be rebutted by showing what both sides actually expected.
A plan may draw its own line, on three conditions. It must be in writing. It must be a specific percentage above 20% and below 50%. And it must be set before separation is named as a time of payment. If you have worked for the employer for less than 36 months, the average is taken over your full period of service.
Who “the Employer” Is
The test is applied across the employer’s whole group. Companies under at least 50% common control count as one employer. So moving from the parent to a 60%-owned subsidiary is not a separation. A plan may set the line anywhere from more than 50% to 80% if it does so in writing in advance. With a legitimate business reason, it may set the line from 20% to 50%.
Leaves of Absence, Consultants and Directors
- Leave of absence
- Military, sick or other bona fide leave does not end employment for up to six months. It can last longer while you keep a right to return under a statute or a contract. Without that right, employment is deemed to end on the first day after the six months. The leave counts as bona fide only if a return is reasonably expected.
- Medical leave
- Some leave is due to an impairment expected to last at least six months, or to end in death. If it stops you doing your job or a similar one, the six months become 29 months.
- Paid and unpaid leave
- For the 20% test, paid leave counts as the level of services needed to earn that pay. Unpaid leave is left out, including from the 36-month look-back.
- Employee to consultant
- Work in either role counts toward the same test. Becoming a contractor at 40% of your former hours is no automatic separation. A change of title alone does not make it one.
- Independent contractors
- A contractor separates when every contract expires and the relationship ends completely and in good faith. If the company expects to renew the contract or to hire the contractor, there is no separation. A plan may instead wait at least 12 months after the last contract ends. It then pays only if no work was done in between.
- Directors
- Sometimes the plans for board service and for employment are not aggregated, meaning not treated as one plan. Then board service is ignored when testing separation as an employee. Employee service is likewise ignored when testing separation as a director.
- Asset sales
- When a business is sold and staff move to an unrelated buyer, buyer and seller may decide whether that is a separation. They must treat everyone consistently and put the choice in writing by closing.
Example of 409A Separation from Service: Four Ways to Step Back
A head of product at a private company averaged 40 hours a week over the past 36 months. She has $200,000 of deferred bonus payable in a lump sum on separation from service. Four versions of her next step give four answers.
Illustrative person, hours and amounts, made up for this page. The level is the expected permanent level as a share of the 36-month average
Tests per Treas. Reg. §1.409A-1(h)(1), as of October 2026
In the second case, the company has to look at how she is treated. If she keeps her title, salary band and benefits, a separation is hard to argue. Paying the $200,000 anyway would be an early payment. That is a failure, and its cost falls on her. The page on 409A penalties works through that cost. If the company were public and she were a key employee, a payable amount would also wait six months under the specified employee rule.
The 409A Separation from Service Definition, as of October 2026
The rules that decide the date. The severance row is an exception from 409A and sits outside the definition. Still, it is usually the first payment the date triggers
As of October 2026 · Treas. Reg. §1.409A-1(h), (b)(9)(iii); §1.409A-3(i)(2); IRS Notice 2025-67
General Information, Not Tax Advice
Whether you have separated from service depends on the facts and on your plan’s written definition. You may be moving to part-time work, a consulting role or a long leave, with deferred pay or severance due on leaving. If so, have a qualified tax adviser review the plan before the change.
Key Risks and Common Mistakes
- Paying on the HR dateA last day in the payroll system does not prove separation if a consulting arrangement at a high level follows.
- The quiet consulting agreementBecoming a contractor at 30–40% of former hours lands in the zone with no presumption. Write the expected level down.
- Long leave with no planWithout a right to return, employment ends after six months, whether anyone notices or not. Payments due on separation then become due.
- Contracts that roll overA contractor whose engagement the company expects to renew has not separated when one contract ends.
- Forgetting the groupMoving to an affiliate under 50% common control is not leaving.
Under 409A, you leave when your work is expected to fall for good to a fifth of what it was. A change of title alone does not count. The date decides when deferred pay can move.
The Terms This Page Uses
- Separation from service
- Death, retirement or termination of employment as Treas. Reg. §1.409A-1(h) defines it, including a permanent drop to 20% or less of former services.
- Bona fide services
- Real work for the employer, as an employee or a contractor. It is the quantity the 20% and 50% tests measure.
- Look-back period
- The 36 months immediately before the change, or the whole period of service if shorter, over which the average is taken.
- Bona fide leave of absence
- Leave from which a return is reasonably expected. It does not end employment for up to six months, or longer with a right to return.
- Involuntary separation
- A separation the employer decides on while the employee was willing and able to keep working. It is the condition for the severance exception.
- Specified employee
- A key employee of a public company, whose separation payments wait six months.
- Change in control
- Another event that often comes with a departure. It has its own 409A test.
What People Ask About 409A Separation from Service
Only if your work is expected to fall permanently to 20% or less of your 36-month average. Your plan may also set its own line in writing, between 20% and 50%, and falling to that line counts too. At 50% or more, you are presumed still in service.
Not automatically. Work as a contractor counts toward the same test. What matters is the expected level of work, whatever the type of contract.
For up to six months, nothing changes. After that, you are treated as separated on the first day after the six months, unless you keep a right to return under a statute or a contract. If the leave is for a qualifying impairment, the period is 29 months.
Close, but the two can differ. A termination followed by substantial consulting work may not be a separation. A sharp, permanent cut in hours can be one without any termination.
No. It applies only to specified employees of a company with publicly traded stock. At a private company, payment can follow separation on the plan’s normal schedule.
Where Every Rule on This Page Comes From
Every rule was checked against the statute and the Treasury regulations on October 2, 2026. The full definition is in Treas. Reg. §1.409A-1(h). The §401(a)(17) limit in the severance row is indexed every year. The example is illustrative and uses no market data.
- 01US Code (Cornell LII)Current law26 U.S.C. §409A(a)(2)(A)(i) — separation from service as a permitted payment event
- 02Code of Federal Regulations (Cornell LII)Current textTreas. Reg. §1.409A-1(h) — definition, presumptions, leave, contractors, employer group, asset sales; (b)(9)(iii) severance exception
- 03Code of Federal Regulations (Cornell LII)Current textTreas. Reg. §1.409A-3(a)(1), (i)(2) — payment on separation and the specified-employee delay
- 04Internal Revenue Service11.2025Notice 2025-67, IRB 2025-49 — §401(a)(17) compensation limit $360,000 for 2026
This page explains how a market works. It is not investment advice, not a recommendation of any security, strategy or company, and not an offer to sell or a solicitation to buy anything. Private companies may never list or be acquired, positions in them can be illiquid for years, and the entire amount invested can be lost. Figures are accurate as of the dates shown and change. Requirements for investor status, and the tax treatment of a private holding, differ by jurisdiction — the jurisdiction is named wherever this page discusses either. Prepared by the AXEVIL Capital research team. Tax rules described here are United States federal rules unless another jurisdiction is named; they change every year and depend on your own facts. Nothing here is tax advice — take your documents to a qualified adviser.
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Where to go from here
TaxesWhat Is Section 409A (Deferred Compensation)? Definition, How It WorksA 409A plan promises pay in a later year. Section 409A sets when that pay may be elected and paid. Break the rules and the employee owes tax at once, plus 20%.
TaxesWhat Is a 409A Specified Employee? Definition, How It Works, ExamplesA 409A specified employee is a key employee of a public company. Deferred pay due when they leave waits six months. Who qualifies and how the delay works.
TaxesWhat Is a 409A Change in Control? Definition, How It Works, ExamplesUnder Section 409A, a change in control is one of the events that may trigger payment of deferred pay. The three tests, their thresholds and an example.